How Do You Predict The Next Real Estate Crash? Mine is...

[Wendell De Guzman]

Mine is foreclosure filings and REO sales.

Let me explain.

In 2007, I was working on 20 shortsales and a business partner of mine was working on about 40 shortsale cases. None of the shortsales were accepted. This was unusual. In 2005-06, we made a lot of money on shortsales and we were able to get banks to approve a big percentage of them.

We worked on some cases for 1 year. When we asked the banks why they are so slow in approving these shortsales, they said they are working on too many foreclosures. At that time, home prices were still rising.

IN 2008, the real estate market crashed.

A foreclosure filing is defined as someone who is behind 3 months or more on their mortgage and they have received a Lis Pendens or Summons to Foreclosure. Of course, there are instances where someone in foreclosure can catch up or do a loan modification and now he is no longer in foreclosure. However, more often than not, someone who is behind on their mortgage is unlikely to get caught up. Eventually, the house gets foreclosed on and becomes banked owned or REO.

My hypothesis is that if the rate of foreclosure filings is higher than REO sales, then the number of REOs will rise to a critical level that it will push prices downwards.

If you're selling your house and you have 3 or more neighbors which are REOs too, there's a good chance you will be forced to sell at a discount. It becomes a vicious cycle: the bank sells their REOs at a discount, pushing the market downwards forcing the banks to sell even lower.

Foreclosure filings is NOT the only indicator. If the banks are able to sell their REOs quickly at a good price (just like what's happening now) and they are ahead of new foreclosure filings, the critical mass of foreclosures won't be reached and the real estate market will continue to rise or remains stable.

So, I track both FORECLOSURE FILINGS and REO Sales.

What about you? What metrics do you track to predict real estate price movements?

[Eric Fernwood]

I will comment on two points related to the market crash issue:

1) Predicting when it is likely to occur. As people stated, tracking NODs is usually the easiest approach I know of. Our source is one of the title companies. What you are looking for is not an absolute number. What you are looking for is the changes in the rate of NOD's. In general, in Las Vegas, NOD's proceed foreclosures by about 6 months and they are likely to hit the market about one year later.

2) What's going to happen to your buy and hold properties during a market crash? Since we have access to actual data (we are Realtors in Las Vegas) we recently decided to look at the rental rates vs. $/SqFt rates from 2008 through 2014. Remember that the crash was severe in Las Vegas, and that most properties went down by 50% or more (many have since recovered to pre-crash values). When we started the study we discovered that the metro area data we could obtain from news sources was virtually worthless because there was no granularity; they averaged the entire metro area and even different property types together in some cases. We choose to base our research on one of the prime rental areas, which is shown in the map below. The property profile we selected is: 3 bedrooms 2 car garage, 1,200 to 1,500 SqFt. 

Using actual sales data from the MLS we looked at property prices ($/SqFt) and below is a chart showing the monthly average $/SqFt sale price between 2008 and 2014.

As you can see, prior to the crash in 2008, conforming properties in the selected area were selling for an average price of approximately $120/SqFt. By 2012 the average price fell to approximately $70/SqFt. What happened to rental rates during the same period? Below is a chart showing $/SqFt rental rates for conforming properties in the same area for the same time period as the above.

As the above shows, rental rates were virtually unaffected by the 2008 real estate market crash. So, if you purchased an investment property in late 2007 at the market peak and the property was generating an 8% return, it continued to generate an 8% return, even though the market value of the property went down 50%. However, this is not true of all areas and even all rent ranges in Las Vegas. Lower end rental properties that were primarily leased by construction workers and such (who really got hurt) fared much worse. I think this shows the importance of selecting the right location and properties that will rent to a stable tenant population. 

In summary, watch for changes in NOD patterns and select properties in locations and rent ranges that are likely to be stable even during a market crash.